Why Microsoft’s $6.2 Billion Charge Matters

At first blush it’s easy to write off Microsoft’s $6.2 billion goodwill impairment charge, announced after the market’s close Monday, as an asterisk to its history that will have little significance to the company and its investors.

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While big enough to wipe out a quarter’s earnings, investors will likely shrug it off because it’ll merely be viewed as a one-time non-cash “accounting” event at a company with $58 billion in cash on hand, operating cash flow of $29 billion and a stock market value of $257 billion.

But the bigger issue is that it reflects a wave of overpaying during the merger frenzy of merger frenzies, when takeover activity in the U.S. peaked at an aggregate $1.2 trillion — as premium upon premium were paid for company after company. Mergers, in turn, helped drive the markets to new highs, fueling investment psychology in the process — just before the market collapsed.

In Microsoft’s case, the takeover in question was for aQuantive, which supposedly would catapult the company into the world of online ad sales. The cost was $6.3 billion, $100 million more than the impairment — suggesting almost the entire deal was a bust.

But it wasn’t the only one, with goodwill impairment write-offs of size increasingly rearing their heads from the class of 2007 and even earlier. Perhaps the most egregious is Rio Tinto's $8 billion-plus in impairments from its 2007 purchase of Alcan for $38 billion. And remember the NYSE's purchase of Euronext for $14 billion in 2007? Earlier this year it wrote off $1.6 billion in goodwill associated with the deal. And let's not forget Procter & Gamble , which earlier this year said it had written off $1.5 billion of its 2005 Gillette purchase.

Goodwill is the amount companies believe they have paid over a company’s perceived fair market value at the time of the deal. If all goes well, the purchased companies grow into their valuation and beyond.

Goodwill is deemed impaired when companies concede they really did overpay. The review of possible impairment is an ongoing process once a deal is completed. But companies don’t have to declare an impairment until they absolutely, positively believe it’s impaired.

Like so much in corporate America, it’s subjective and ignored by almost everybody by the accounting geeks in the crowd.

But it is possible this round of impairment may wind up going too far?

“It reminds me of all the loan loss provision charges banks took and how at the beginning of them everybody said they didn't matter because the charges were non-cash and banks had plenty of capital,” says Peter Atwater, president of Financial Incytes, a private financial consulting firm. He’s also one of the smartest below-the-radar observers of arcane financial matters I know.

He adds: “To me this deal opens up a real question as to whether the current accounting for M&A is correct. There was no cost to companies to acquire and overpay.

“It was a like a free option. If things went well, there was never a cost and if things went south, like Microsoft, the charge wouldn't take place for years and at that point it could be painted as ‘non-cash accounting charge.’

“Who wouldn't want to live in an accounting world like that.

“Mark my words, the accounting here will change just like it has for every other top of the market abuse.”

If Peter’s right — and he usually is — it won’t change in a way that lets companies make overpaying for acquisitions seem like little more than an accounting after-thought by managements trying to erase the memory of a bad business decision.

After all, investment managers can't get away by writing off a bad investment as a non-cash charge. Maybe one day companies won't be able to, either.